sfm-10q_20150927.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 27, 2015

Commission File Number: 001-36029

 

Sprouts Farmers Market, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

32-0331600

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

5455 East High Street, Suite 111

Phoenix, Arizona 85054

(Address of principal executive offices and zip code)

(480) 814-8016

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

x

Accelerated filer

o

 

 

 

 

Non-accelerated filer

o  (Do not check if a smaller reporting company)

Smaller reporting company

o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o   No x

As of November 3, 2015, there were outstanding 153,590,850 shares of the registrant’s common stock, $0.001 par value per share.

 

 

 


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 27, 2015

TABLE OF CONTENTS

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

 

Item 1. Financial Statements.

1

 

 

 

 

Consolidated Balance Sheets as of September 27, 2015 and December 28, 2014 (unaudited)

1

 

 

 

 

Consolidated Statements of Operations for the thirteen and thirty-nine weeks ended September 27, 2015 and September 28, 2014 (unaudited)

2

 

 

 

 

Consolidated Statements of Stockholders’ Equity for the thirty-nine weeks ended September 27, 2015 and the year ended December 28, 2014 (unaudited)

3

 

 

 

 

Consolidated Statements of Cash Flows for the thirty-nine weeks ended September 27, 2015 and September 28, 2014 (unaudited)

4

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

5

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

28

 

 

Item 4. Controls and Procedures.

28

 

 

PART II - OTHER INFORMATION

 

 

 

Item 1. Legal Proceedings.

30

 

 

Item 1A. Risk Factors.

30

 

 

Item 5. Other Information.

30

 

 

Item 6. Exhibits.

31

 

 

Signatures

32

 

 

i


Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve substantial risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (referred to as the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (referred to as the “Exchange Act”), including, but not limited to, statements regarding our expectations, beliefs, intentions, strategies, future operations, future financial position, future revenue, projected expenses, and plans and objectives of management. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “will,” “would,” “should,” “could,” “can,” “predict,” “potential,” “continue,” “objective,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and involve known risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievement to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors” included in this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for the fiscal year ended December 28, 2014, and our other filings with the Securities and Exchange Commission. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

As used in this Quarterly Report on Form 10-Q, unless the context otherwise requires, references to the “Company,” “Sprouts,” “we,” “us” and “our” refer to Sprouts Farmers Market, Inc. and, where appropriate, its subsidiaries.

 

 

 

ii


PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

 

 

 

September 27,

2015

 

 

December 28,

2014

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

132,000

 

 

$

130,513

 

Accounts receivable, net

 

 

24,997

 

 

 

14,091

 

Inventories

 

 

161,789

 

 

 

142,793

 

Prepaid expenses and other current assets

 

 

11,279

 

 

 

11,152

 

Deferred income tax asset

 

 

31,806

 

 

 

35,580

 

Total current assets

 

 

361,871

 

 

 

334,129

 

Property and equipment, net of accumulated depreciation

 

 

482,317

 

 

 

454,889

 

Intangible assets, net of accumulated amortization

 

 

193,207

 

 

 

194,176

 

Goodwill

 

 

368,078

 

 

 

368,078

 

Other assets

 

 

19,082

 

 

 

17,801

 

Total assets

 

$

1,424,555

 

 

$

1,369,073

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

138,656

 

 

$

112,877

 

Accrued salaries and benefits

 

 

23,436

 

 

 

29,687

 

Other accrued liabilities

 

 

41,077

 

 

 

41,394

 

Current portion of capital and financing lease obligations

 

 

14,625

 

 

 

29,136

 

Current portion of long-term debt

 

 

 

 

 

7,746

 

Total current liabilities

 

 

217,794

 

 

 

220,840

 

Long-term capital and financing lease obligations

 

 

116,668

 

 

 

121,562

 

Long-term debt

 

 

160,000

 

 

 

248,611

 

Other long-term liabilities

 

 

95,469

 

 

 

74,071

 

Deferred income tax liability

 

 

17,980

 

 

 

18,600

 

Total liabilities

 

 

607,911

 

 

 

683,684

 

Commitments and contingencies (Note 10)

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Undesignated preferred stock; $0.001 par value; 10,000,000 shares

   authorized, no shares issued and outstanding

 

 

 

 

 

 

Common stock, $0.001 par value; 200,000,000 shares authorized,

   153,589,350 and 151,833,334 shares issued and outstanding,

   September 27, 2015 and December 28, 2014, respectively

 

 

154

 

 

 

152

 

Additional paid-in capital

 

 

573,526

 

 

 

543,048

 

Retained earnings

 

 

242,964

 

 

 

142,189

 

Total stockholders’ equity

 

 

816,644

 

 

 

685,389

 

Total liabilities and stockholders’ equity

 

$

1,424,555

 

 

$

1,369,073

 

 

The accompanying notes are an integral part of these consolidated financial statements.  

 

 

 

1


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

 

 

 

Thirteen Weeks Ended

 

 

Thirty-Nine Weeks Ended

 

 

 

September 27,

2015

 

 

September 28,

2014

 

 

September 27,

2015

 

 

September 28,

2014

 

Net sales

 

$

903,069

 

 

$

766,415

 

 

$

2,662,728

 

 

$

2,232,831

 

Cost of sales, buying and occupancy

 

 

641,612

 

 

 

540,367

 

 

 

1,879,839

 

 

 

1,558,876

 

Gross profit

 

 

261,457

 

 

 

226,048

 

 

 

782,889

 

 

 

673,955

 

Direct store expenses

 

 

177,990

 

 

 

148,633

 

 

 

518,561

 

 

 

430,019

 

Selling, general and administrative expenses

 

 

27,075

 

 

 

24,015

 

 

 

74,492

 

 

 

69,594

 

Store pre-opening costs

 

 

1,825

 

 

 

3,684

 

 

 

7,105

 

 

 

7,051

 

Store closure and exit costs

 

 

167

 

 

 

60

 

 

 

1,711

 

 

 

393

 

Income from operations

 

 

54,400

 

 

 

49,656

 

 

 

181,020

 

 

 

166,898

 

Interest expense

 

 

(3,685

)

 

 

(6,157

)

 

 

(13,990

)

 

 

(19,144

)

Other income

 

 

171

 

 

 

281

 

 

 

345

 

 

 

477

 

Loss on extinguishment of debt

 

 

-

 

 

 

(1,138

)

 

 

(5,481

)

 

 

(1,138

)

Income before income taxes

 

 

50,886

 

 

 

42,642

 

 

 

161,894

 

 

 

147,093

 

Income tax provision

 

 

(18,900

)

 

 

(16,577

)

 

 

(61,119

)

 

 

(57,144

)

Net income

 

$

31,986

 

 

$

26,065

 

 

$

100,775

 

 

$

89,949

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.21

 

 

$

0.17

 

 

$

0.66

 

 

$

0.60

 

Diluted

 

$

0.21

 

 

$

0.17

 

 

$

0.65

 

 

$

0.58

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

153,585

 

 

 

150,241

 

 

 

153,071

 

 

 

149,227

 

Diluted

 

 

155,952

 

 

 

154,306

 

 

 

155,841

 

 

 

153,879

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

2


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

 

 

 

Shares

 

 

Common

Stock

 

 

Additional

Paid In

Capital

 

 

Retained

Earnings

 

 

Total

Stockholders’

Equity

 

Balances at December 29, 2013

 

 

147,616,560

 

 

$

147

 

 

$

479,127

 

 

$

34,497

 

 

$

513,771

 

Net income

 

 

 

 

 

 

 

 

 

 

 

107,692

 

 

 

107,692

 

Issuance of shares under option plans

 

 

4,216,774

 

 

 

5

 

 

 

11,307

 

 

 

 

 

 

11,312

 

Excess income tax benefit for exercise of

   options

 

 

 

 

 

 

 

 

47,261

 

 

 

 

 

 

47,261

 

Tax effect of forfeiture of vested options in

   equity

 

 

 

 

 

 

 

 

(2

)

 

 

 

 

 

(2

)

Equity-based compensation

 

 

 

 

 

 

 

 

5,355

 

 

 

 

 

 

5,355

 

Balances at December 28, 2014

 

 

151,833,334

 

 

$

152

 

 

$

543,048

 

 

$

142,189

 

 

$

685,389

 

Net income

 

 

 

 

 

 

 

 

 

 

 

100,775

 

 

 

100,775

 

Issuance of shares under option plans

 

 

1,756,016

 

 

 

2

 

 

 

6,120

 

 

 

 

 

 

6,122

 

Excess income tax benefit for exercise of

   options

 

 

 

 

 

 

 

 

19,584

 

 

 

 

 

 

19,584

 

Equity-based compensation

 

 

 

 

 

 

 

 

4,774

 

 

 

 

 

 

4,774

 

Balances at September 27, 2015

 

 

153,589,350

 

 

$

154

 

 

$

573,526

 

 

$

242,964

 

 

$

816,644

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

 

 

 

Thirty-Nine Weeks Ended

 

 

 

September 27,

2015

 

 

September 28,

2014

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income

 

$

100,775

 

 

$

89,949

 

Adjustments to reconcile net income to net cash provided by operating

   activities:

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

50,665

 

 

 

40,586

 

Accretion of asset retirement obligation and closed facility reserve

 

 

251

 

 

 

755

 

Amortization of financing fees and debt issuance costs

 

 

617

 

 

 

1,152

 

Loss on disposal of property and equipment

 

 

1,257

 

 

 

1,038

 

Equity-based compensation

 

 

4,776

 

 

 

4,194

 

Loss on extinguishment of debt

 

 

5,481

 

 

 

1,138

 

Deferred income taxes

 

 

3,155

 

 

 

13,067

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(11,150

)

 

 

(4,654

)

Inventories

 

 

(18,996

)

 

 

(21,848

)

Prepaid expenses and other current assets

 

 

(25

)

 

 

1,617

 

Other assets

 

 

(444

)

 

 

(5,474

)

Accounts payable

 

 

28,641

 

 

 

7,094

 

Accrued salaries and benefits

 

 

(6,251

)

 

 

3,374

 

Other accrued liabilities and income taxes payable

 

 

(370

)

 

 

5,814

 

Other long-term liabilities

 

 

20,709

 

 

 

13,499

 

Net cash provided by operating activities

 

 

179,091

 

 

 

151,301

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(97,390

)

 

 

(96,099

)

Proceeds from sale of property and equipment

 

 

49

 

 

 

232

 

Net cash used in investing activities

 

 

(97,341

)

 

 

(95,867

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from revolving credit facility

 

 

260,000

 

 

 

 

Payments on revolving credit facility

 

 

(100,000

)

 

 

 

Payments on term loan

 

 

(261,250

)

 

 

(55,250

)

Payments on capital lease obligations

 

 

(492

)

 

 

(426

)

Payments on financing lease obligations

 

 

(2,575

)

 

 

(2,186

)

Payments of deferred financing costs

 

 

(1,896

)

 

 

 

Cash from landlord related to financing lease obligations

 

 

 

 

 

577

 

Excess tax benefit for exercise of stock options

 

 

19,584

 

 

 

35,041

 

Proceeds from the exercise of stock options

 

 

6,366

 

 

 

7,605

 

Net cash used in financing activities

 

 

(80,263

)

 

 

(14,639

)

Net increase in cash and cash equivalents

 

 

1,487

 

 

 

40,795

 

Cash and cash equivalents at beginning of the period

 

 

130,513

 

 

 

77,652

 

Cash and cash equivalents at the end of the period

 

$

132,000

 

 

$

118,447

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

14,174

 

 

$

18,164

 

Cash paid for income taxes

 

 

35,075

 

 

 

3,982

 

 

 

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing

   activities

 

 

 

 

 

 

 

 

Property and equipment in accounts payable

 

$

11,141

 

 

$

12,156

 

Property acquired through capital and financing lease obligations

 

 

9,899

 

 

 

9,113

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

1. Basis of Presentation

Sprouts Farmers Market, Inc., a Delaware corporation, through its subsidiaries, operates as a healthy grocery store that offers fresh, natural and organic food that includes fresh produce, bulk foods, vitamins and supplements, grocery, meat and seafood, bakery, dairy, frozen foods, body care and natural household items catering to consumers’ growing interest in eating and living healthier. The “Company” is used to refer collectively to Sprouts Farmers Market, Inc. and unless the context otherwise requires, its subsidiaries.

The accompanying unaudited consolidated financial statements include the accounts of the Company in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial statements and are in the form prescribed by the Securities and Exchange Commission in instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, considered necessary for a fair statement of the Company's financial position, results of operations and cash flows for the periods indicated.  All material intercompany accounts and transactions have been eliminated in consolidation. Interim results are not necessarily indicative of results for any other interim period or for a full fiscal year. The information included in these consolidated financial statements and notes thereto should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto for the fiscal year ended December 28, 2014 included in the Company’s Annual Report on Form 10-K, filed on February 26, 2015.

The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

The Company reports its results of operations on a 52- or 53-week fiscal calendar ending on the Sunday closest to December 31. Fiscal year 2015 is a 53-week year, and Fiscal year 2014 was a 52-week year. The Company reports its results of operations on a 13-week quarter, except for 53-week fiscal years. The fourth quarter of fiscal 2015 will include 14 weeks.

The Company has one reportable and one operating segment.

The Company’s business is subject to modest seasonality.  Average weekly sales fluctuate throughout the year and are typically highest in the first half of the fiscal year. Produce, which contributed 25% of the Company’s net sales for the thirty-nine weeks ended September 27, 2015, is generally more available in the first six months of the fiscal year due to the timing of peak growing seasons.

During thirteen weeks ended June 28, 2015, the Company obtained sufficient historical redemption data for its gift card program to make a reasonable estimate of the ultimate redemption patterns and breakage rate. Accordingly, the Company recognized $0.1 million and $0.8 million of gift card breakage as a component of net sales in the accompanying Consolidated Statements of Operations for the thirteen and thirty-nine weeks ended September 27, 2015, respectively.

During the thirteen weeks ended September 27, 2015, the Company changed its store inventory count procedure and no longer counted each store at the end of the quarter. Previously the Company had counted inventory at each store at or near the balance sheet date and therefore recorded no estimate for shrink. The Company now counts store inventories on a rotational basis throughout the quarter.  The change in timing necessitates making an estimate for shrink between the count date for each store and the reporting date. Accordingly, the inventory balance in the accompanying Consolidated Balance Sheets includes a $3.8 million inventory shrink reserve as of September 27, 2015.

All dollar amounts are in thousands, unless otherwise noted.

 

5


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

2. Recently Issued Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” ASU No. 2014-08 amends previous guidance related to the criteria for reporting a disposal as a discontinued operation by elevating the threshold for qualification for discontinued operations treatment to a disposal that represents a strategic shift that has a major effect on an organization’s operations or financial results. This guidance also requires expanded disclosures for transactions that qualify as a discontinued operation and requires disclosure of individually significant components that are disposed of or held for sale but do not qualify for discontinued operations reporting.  This guidance is effective prospectively for all disposals or components initially classified as held for sale in periods beginning on or after December 15, 2014, with early adoption permitted.  The Company’s adoption of this guidance did not have a material effect on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” ASU No. 2014-09 provides guidance for revenue recognition.  The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance.  These may include identifying performance obligations in the contract, and estimating the amount of variable consideration to include in the transaction price attributable to each separate performance obligation.  This guidance will be effective for the Company for its fiscal year 2017.  The FASB recently deferred the effective date of this guidance by one year, with early adoption permitted. The Company is currently evaluating the potential impact of this guidance.

In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” ASU No. 2014-15 requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures in certain circumstances.  This guidance will be effective for the Company for its fiscal year 2017, with early adoption permitted.  The Company does not expect the adoption of this guidance to have a material effect on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” ASU No. 2015-03 requires an entity to present debt issuance costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs will continue to be reported as interest expense. This guidance will be effective for the Company for its fiscal year 2017. Early adoption is permitted. The new guidance will be applied retrospectively to each prior period presented. The Company is currently evaluating the potential impact of this guidance.

In April 2015, the FASB issued ASU No. 2015-05, “Customer's Accounting for Fees Paid in a Cloud Computing Arrangement.” ASU No. 2015-05 provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If the arrangement does not include a software license, the customer should account for a cloud computing arrangement as a service contract. This guidance will be effective for the Company for its fiscal year 2016. Early adoption is permitted. The amendment may be adopted either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The Company is currently evaluating the potential impact of this guidance.

In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory.” ASU No. 2015-11 changes the measurement principle for inventory from the lower of cost or market to lower of cost and net realizable value. Net realizable value is defined as the estimated selling prices in the ordinary course of business; less reasonably predictable costs of completion, disposal and transportation. This guidance will be effective for the Company for its fiscal year 2017. The Company is currently evaluating the potential impact of this guidance.

6


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

In September 2015, the FASB issued ASU No. 2015-16, “Business Combinations: Simplifying the Accounting For Measurement Period Adjustments.” ASU No. 2015-16 requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. This guidance will be effective for the Company for its fiscal year 2016. The Company does not expect the adoption of this guidance to have a material effect on its consolidated financial statements.

No other new accounting pronouncements issued or effective during the period had, or are expected to have, a material impact on the Company’s consolidated financial statements.

 

3. Fair Value Measurements

The Company records its financial assets and liabilities in accordance with the framework for measuring fair value in accordance with GAAP. This framework establishes a fair value hierarchy that prioritizes the inputs used to measure fair value:

Level 1: Quoted prices for identical instruments in active markets.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3: Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Fair value measurements of nonfinancial assets and nonfinancial liabilities are primarily used in the impairment analysis of goodwill, indefinite-lived intangible assets and long-lived assets and in the valuation of store closure and exit costs.

The determination of fair values of certain tangible and intangible assets for purposes of the Company’s goodwill impairment evaluation as described above was based upon a step zero assessment. Closed facility reserves are recorded at net present value to approximate fair value which is classified as Level 3 in the hierarchy. The estimated fair value of the closed facility reserve is calculated based on the present value of the remaining lease payments and other charges using a weighted average cost of capital, reduced by estimated sublease rentals. The weighted average cost of capital was estimated using information from comparable companies and management’s judgment related to the risk associated with the operations of the stores.

Cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, accrued salaries and benefits and other accrued liabilities approximate fair value because of the short maturity of those instruments. Based on open market transactions comparable to the Credit Facility (as defined in Note 6, “Long-Term Debt”), the fair value of the long-term debt, including current maturities, approximates carrying value as of September 27, 2015. Based on open market transactions comparable to the Former Term Loan (as defined in Note 6, “Long-Term Debt”), the fair value of the long-term debt, approximates carrying value as of December 28, 2014.The Company’s estimates of the fair value of long-term debt (including current maturities) were classified as Level 2 in the fair value hierarchy.

 

7


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

4. Accounts Receivable

A summary of accounts receivable is as follows:

 

 

 

As Of

 

 

 

September 27,

2015

 

 

December 28,

2014

 

Vendor

 

$

15,207

 

 

$

8,246

 

Receivables from landlords

 

 

6,808

 

 

 

1,993

 

Other

 

 

2,982

 

 

 

3,852

 

Total

 

$

24,997

 

 

$

14,091

 

 

The Company had recorded allowances for certain vendor receivables of $0.1 million and $0.3 million at September 27, 2015 and December 28, 2014, respectively.

Other receivables at December 28, 2014 included amounts receivable for payroll taxes and exercise prices for options exercised but for which the cash was not received by the balance sheet date.

 

5. Accrued Salaries and Benefits

A summary of accrued salaries and benefits is as follows:

 

 

 

As Of

 

 

 

September 27,

2015

 

 

December 28,

2014

 

Accrued payroll

 

$

9,228

 

 

$

9,196

 

Vacation

 

 

8,970

 

 

 

7,476

 

Bonus

 

 

4,295

 

 

 

12,138

 

Other

 

 

943

 

 

 

877

 

Total

 

$

23,436

 

 

$

29,687

 

 

 

6. Long-Term Debt

A summary of long-term debt is as follows:

 

 

 

 

 

 

 

As Of

 

Facility

 

Maturity

 

Interest Rate

 

September 27,

2015

 

 

December 28,

2014

 

Senior secured debt

 

 

 

 

 

 

 

 

 

 

 

 

$450.0 million Credit Facility

 

April 17, 2020

 

Variable

 

$

160,000

 

 

$

 

Former Term Loan, net of original issue discount

 

April 23, 2020

 

Variable

 

 

 

 

$

256,357

 

Former Revolving Credit Facility

 

April 23, 2018

 

Variable

 

 

 

 

 

 

Total debt

 

 

 

 

 

 

160,000

 

 

 

256,357

 

Less current portion

 

 

 

 

 

 

 

 

 

(7,746

)

Long-term debt, net of current portion

 

 

 

 

 

$

160,000

 

 

$

248,611

 

 

Current portion of long-term debt is presented net of issue discount of $1.0 million as of December 28, 2014. The non-current portion of long-term debt is presented net of issue discount of $3.9 million as of December 28, 2014.

Senior Secured Revolving Credit Facility

April 2015 Refinancing

On April 17, 2015, the Company’s subsidiary, Sprouts Farmers Markets Holdings, LLC (“Intermediate Holdings”), as borrower, entered into a credit agreement (the “Credit Agreement”) to replace the Former Revolving Credit Facility and Former Term Loan (each as defined below). The Credit

8


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Agreement provides for a revolving credit facility with an initial aggregate commitment of $450.0 million (the “Credit Facility”), which may be increased from time to time pursuant to an expansion feature set forth in the Credit Agreement.

Concurrently with the closing of the Credit Agreement, the Company borrowed $260.0 million to pay off its existing $257.8 million Former Term Loan (the “April 2015 Refinancing”), and to terminate all commitments under its existing senior secured credit facility, dated April 23, 2013 (the “Former Credit Facility”) and to pay transaction costs related to the April 2015 Refinancing. Such repayment resulted in a $5.5 million loss on extinguishment of debt due to the write-off of deferred financing costs and original issue discount. No amounts were outstanding under the Former Revolving Credit Facility on April 17, 2015. The remaining proceeds of loans made under the Credit Facility were used for general corporate purposes.

The Company capitalized debt issuance costs of $2.3 million related to the Credit Facility, which are being amortized on a straight-line basis to interest expense over the five-year term of the Credit Facility.

The Credit Agreement also provides for a letter of credit subfacility and a $15.0 million swingline facility. Letters of credit issued under the Credit Agreement reduce the borrowing capacity of the Credit Facility. Letters of credit totaling $2.5 million have been issued as of September 27, 2015, primarily to support the Company’s insurance programs.

Guarantees

Obligations under the Credit Facility are guaranteed by the Company and all of its current and future wholly-owned material domestic subsidiaries, and are secured by first-priority security interests in substantially all of the assets of the Company and its subsidiary guarantors, including, without limitation, a pledge by the Company of its equity interest in Intermediate Holdings.

Interest and Fees    

Loans under the Credit Facility bear interest, at the Company’s option, either at adjusted LIBOR plus 1.25% per annum, or a base rate plus 0.25% per annum. The interest rate margins are subject to adjustment pursuant to a pricing grid based on the Company’s total gross leverage ratio, as defined in the Credit Agreement. Under the terms of the Credit Agreement, the Company is obligated to pay a commitment fee on the available unused amount of the Credit Facility commitments equal to 0.15% per annum.

Outstanding letters of credit under the Credit Facility are subject to a participation fee of 1.25% per annum and an issuance fee of 0.125% per annum.

Payments and Prepayments    

The Credit Facility is scheduled to mature, and the commitments thereunder will terminate on April 17, 2020, subject to extensions as set forth the in the Credit Agreement.

The Company may repay loans and reduce commitments under the Credit Agreement at any time in agreed-upon minimum principal amounts, without premium or penalty (except LIBOR breakage costs, if applicable).

Following the closing of the Credit Facility and the initial borrowing of $260.0 million, the Company made a total of $100.0 million of principal payments on the Credit Facility, which reduced the Company’s total outstanding debt to $160.0 million at September 27, 2015.

9


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Covenants    

The Credit Agreement contains financial, affirmative and negative covenants.  The negative covenants include, among other things, limitations on the Company’s ability to:

 

·

incur additional indebtedness;

 

·

grant additional liens;

 

·

enter into sale-leaseback transactions;

 

·

make loans or investments;

 

·

merge, consolidate or enter into acquisitions;

 

·

pay dividends or distributions;

 

·

enter into transactions with affiliates;

 

·

enter into new lines of business;

 

·

modify the terms of debt or other material agreements; and

 

·

change its fiscal year

Each of these covenants is subject to customary and other agreed-upon exceptions.

In addition, the Credit Agreement requires that the Company and its subsidiaries maintain a maximum total net leverage ratio not to exceed 3.00 to 1.00 and minimum interest coverage ratio not to be less than 1.75 to 1.00. Each of these covenants is tested on the last day of each fiscal quarter, starting with the fiscal quarter ended June 28, 2015.

The Company was in compliance with all applicable covenants under the Credit Agreement as of September 27, 2015.

Former Credit Facility

On April 23, 2013, Intermediate Holdings, as borrower, refinanced (the “April 2013 Refinancing”) its prior revolving credit facility and prior term loan, by entering into the Former Credit Facility. The Former Credit Facility provided for a $700.0 million term loan (the “Former Term Loan”) and a $60.0 million senior secured revolving credit facility (the “Former Revolving Credit Facility”).

The Former Term Loan, with a maturity date in April 2020, required quarterly principal payments, in an aggregate amount equal to 1.00% of the original principal balance, with the balance due on the final maturity date.

All amounts outstanding under the Former Term Loan bore interest, at the Company’s option, at a rate per annum equal to LIBOR (with a 1.00% floor with respect to Eurodollar borrowings under the Term Loan), adjusted for statutory reserves, plus a margin equal to 3.00%, or an alternate base rate, plus a margin equal to 2.00%, as set forth in the Former Credit Facility.

The Former Credit Facility included the $60.0 million Former Revolving Credit Facility with a maturity date in April 2018. The Former Revolving Credit Facility included letter of credit and $5.0 million swingline loan subfacilities.  Letters of credit issued under the Former Revolving Credit Facility reduced the borrowing capacity on the Former Credit Facility.

Interest terms on the Former Revolving Credit Facility were the same as the Former Term Loan.

The Company capitalized debt issuance costs of $1.1 million related to the Former Revolving Credit Facility, which were being amortized to interest expense over the term of the Former Revolving Credit Facility.

10


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Under the terms of the Former Credit Facility, the Company was obligated to pay a commitment fee on the available unused amount of the Former Revolving Credit Facility commitments equal to 0.50% per annum.

 

7. Closed Facility Reserves

The following is a summary of closed facility reserve activity during the thirty-nine weeks ended September 27, 2015 and fiscal year ended December 28, 2014:

 

 

 

September 27,

2015

 

 

December 28,

2014

 

Beginning balance

 

$

1,785

 

 

$

4,713

 

Additions

 

 

1,144

 

 

 

688

 

Usage

 

 

(1,004

)

 

 

(3,204

)

Adjustments

 

 

389

 

 

 

(412

)

Ending balance

 

$

2,314

 

 

$

1,785

 

 

Additions made during 2015 include remaining lease payments for the corporate support office relocation, and usage during 2015 primarily related to lease payments made during the period for closed stores. Additions made during 2014 related to the closure and relocation of one store and to the closure and relocation of the Texas warehouse, and usage during 2014 related to lease payments made during the period for closed stores.

 

8. Income Taxes

The Company’s effective tax rate for the thirteen weeks ended September 27, 2015 and September 28, 2014 was 37.1% and 38.9%, respectively. The primary reasons for the decrease in the effective tax rate were an increase in the enhanced deduction for charitable donations of food inventory and a decrease in the effective state income tax rate.

The Company’s effective tax rate for the thirty-nine weeks ended September 27, 2015 and September 28, 2014 was 37.8% and 38.9%, respectively. The primary reasons for the decrease in the effective tax rate were an increase in the enhanced deduction for charitable donations of food inventory and a decrease in the effective state income tax rate.

Excess tax benefits associated with stock option exercises and vested restricted stock units are credited to stockholders’ equity.  The Company uses the tax law ordering approach of intraperiod allocation to allocate the benefit of windfall tax benefits based on provisions in the tax law that identify the sequence in which those amounts are utilized for tax purposes.  The income tax benefits resulting from stock awards that were credited to stockholders’ equity were $19.6 million for the thirty-nine weeks ended September 27, 2015, which included $0.1 million of income tax benefits related to stock award activity prior to 2015. The excess tax benefits are not credited to stockholders’ equity until the deduction reduces income taxes payable.

 

9. Related-Party Transactions

A member of the Company’s board of directors is an investor in a company that is a supplier of coffee to the Company. During the thirteen weeks ended September 27, 2015 and September 28, 2014, purchases from this supplier were $2.3 million and $2.0 million, respectively. During the thirty-nine weeks ended September 27, 2015 and September 28, 2014, purchases from this supplier were $7.1 million and $5.8 million, respectively. At September 27, 2015 and September 28, 2014, the Company had recorded accounts payable due to this supplier of $0.7 million and $0.6 million, respectively.

 

On November 3, 2015, the Company entered into an agreement to purchase an airplane from this board member for $7.5 million. The transaction is expected to close during November 2015, subject to customary pre-closing inspection.

Another member of the Company’s board of directors purchased stock in a technology supplier to the Company in January 2015 and provided a loan to this company in May 2015. During the thirteen

11


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

weeks ended September 27, 2015 and September 28, 2014, purchases from this supplier were $1.7 million and $1.3 million, respectively. During the thirty-nine weeks ended September 27, 2015 and September 28, 2014, purchases from this supplier were $4.8 million and $4.2 million, respectively. At September 27, 2015 and September 28, 2014, the Company had recorded accounts payable due to this supplier of $0.2 million and zero, respectively.

 

This board member also provided a convertible loan to a technology supplier to the Company in September 2015. During the thirteen weeks ended September 27, 2015 and September 28, 2014, purchases from this supplier were $0.2 million and $0.3 million, respectively. During the thirty-nine weeks ended September 27, 2015 and September 28, 2014, purchases from this supplier were $0.4 million and $0.6 million, respectively. At both September 27, 2015 and September 28, 2014, the Company had recorded accounts payable due to this supplier of $0.1 million.

 

10. Commitments and Contingencies

The Company is exposed to claims and litigation matters arising in the ordinary course of business and uses various methods to resolve these matters that are believed to best serve the interests of the Company’s stakeholders. The Company’s primary contingencies are associated with self-insurance obligations. Self-insurance liabilities require significant judgment and actual claim settlements and associated expenses may differ from the Company’s current provisions for loss.

 

11. Stockholders’ Equity

Secondary Offering

On March 10, 2015, certain of the Company’s stockholders completed a secondary public offering of 15,847,800 shares of common stock (the “March Secondary Offering”). The Company did not sell any shares in or receive any proceeds of the March Secondary Offering.

 

12. Net Income Per Share

The computation of net income per share is based on the number of weighted average shares outstanding during the period. The computation of diluted net income per share includes the dilutive effect of share equivalents consisting of incremental shares deemed outstanding from the assumed exercise of options, assumed vesting of restricted stock units (“RSUs”) and assumed vesting of performance stock awards (“PSAs”).

A reconciliation of the numerators and denominators of the basic and diluted net income per share calculations is as follows (in thousands, except per share amounts):

 

 

 

Thirteen Weeks Ended

 

 

Thirty-Nine Weeks Ended

 

 

 

September 27,

2015

 

 

September 28,

2014

 

 

September 27,

2015

 

 

September 28,

2014

 

Basic net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

31,986

 

 

$

26,065

 

 

$

100,775

 

 

$

89,949

 

Weighted average shares outstanding

 

 

153,585

 

 

 

150,241

 

 

 

153,071

 

 

 

149,227

 

Basic net income per share

 

$

0.21

 

 

$

0.17

 

 

$

0.66

 

 

$

0.60

 

Diluted net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

31,986

 

 

$

26,065

 

 

$

100,775

 

 

$

89,949

 

Weighted average shares outstanding

 

 

153,585

 

 

 

150,241

 

 

 

153,071

 

 

 

149,227

 

Dilutive effect of equity-based awards:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assumed exercise of options to purchase shares

 

 

2,360

 

 

 

4,065

 

 

 

2,739

 

 

 

4,652

 

Restricted stock units

 

 

7

 

 

 

 

 

 

31

 

 

 

 

Weighted average shares and equivalent

   shares outstanding

 

 

155,952

 

 

 

154,306

 

 

 

155,841

 

 

 

153,879

 

Diluted net income per share

 

$

0.21

 

 

$

0.17

 

 

$

0.65

 

 

$

0.58

 

 

12


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

For the thirteen weeks ended September 27, 2015, the computation of diluted net income per share does not include 2.9 million options as those options would have been antidilutive or were unvested performance-based options and 0.1 million RSUs as those RSUs would have been antidilutive, and 0.1 million for PSAs. For the thirteen weeks ended September 28, 2014, the computation of diluted net income per share does not include 1.0 million options, as those options would have been antidilutive or were unvested performance-based options.

For the thirty-nine weeks ended September 27, 2015 the computation of diluted net income per share does not include 0.8 million options, as those options would have been antidilutive or were unvested performance-based options, and 0.1 million for PSAs. For the thirty-nine weeks ended September 28, 2014, the computation of diluted net income per share does not include 1.0 million options, as those options would have been antidilutive or were unvested performance-based options.

 

13. Equity-Based Compensation

2013 Incentive Plan

The Company’s board of directors adopted, and its equity holders approved, the Sprouts Farmers Market, Inc. 2013 Incentive Plan (the “2013 Incentive Plan”). The 2013 Incentive Plan became effective July 31, 2013 in connection with the Company’s initial public offering (IPO) and replaced the Sprouts Farmers Markets, LLC Option Plan (the “2011 Option Plan”) (except with respect to outstanding options to acquire shares under the 2011 Option Plan). The 2013 Incentive Plan and 2011 Option Plan are collectively referred to as the “Option Plans”. The 2013 Incentive Plan serves as the umbrella plan for the Company’s stock-based and cash-based incentive compensation programs for its directors, officers and other team members. On May 1, 2015, the Company’s stockholders approved the material terms of the performance goals under the 2013 Incentive Plan for purposes of Section 162(m) of the Internal Revenue Code.

On March 11, 2015, under the 2013 Incentive Plan, the Company granted to certain officers and team members time-based options to purchase an aggregate of 277,833 shares of common stock at an exercise price of $34.33 per share, with a grant date fair value of $9.42 per share.  The Company also granted an aggregate of 87,394 RSUs (as described below), each with a grant date fair value of $34.33, and 71,753 PSAs (as described below), each with a grant date fair value of $34.33.

On May 21, 2015, under the 2013 Incentive Plan, the Company granted to independent members of its board of directors time-based options to purchase an aggregate of 14,492 shares of common stock at an exercise price of $30.30 per share, with a grant date fair value of $8.28 per share. The Company also granted to the independent directors an aggregate of 3,896 RSUs, each with a grant date fair value of $30.30.

On August 11, 2015, under the 2013 Incentive Plan, the Company granted to certain officers, an independent member of its board of directors, and certain team members time-based options to purchase an aggregate of 2,138,899 shares of common stock at an exercise price of $20.98 per share, with a grant date fair value of $5.79 per share.  The Company also granted an aggregate of 5,660 RSUs, each with a grant date fair value of $20.98 to an independent member of its board of directors and certain team members.

The aggregate number of shares of common stock that may be issued to team members and directors under the 2013 Incentive Plan may not exceed 10,089,072. Shares subject to awards granted under the 2013 Incentive Plan which are subsequently forfeited, expire unexercised or are otherwise not issued will not be treated as having been issued for purposes of the share limitation. At September 27, 2015, there were 3,046,737 options outstanding under the 2013 Incentive Plan.

2011 Option Plan

In May 2011, the Company adopted the 2011 Option Plan to provide team members or directors of the Company with options to acquire shares of the Company. The Company had authorized 12,100,000

13


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

shares for issuance under the 2011 Option Plan. Options may no longer be issued under the 2011 Option Plan. At September 27, 2015, there were 4,410,452 options outstanding under the 2011 Option Plan.

Options

The Company uses the Black-Scholes option pricing model to estimate the fair value of options at grant date. Options vest in accordance with the terms set forth in the grant letter and vary depending on if they are time-based or performance-based.

Time-based options generally vest ratably over a period of 12 quarters (three years) and performance-based options vest over a period of three years based on financial performance targets set for each year.

RSUs

The fair value of RSUs is based on the closing price of the Company’s common stock on the grant date. RSUs generally vest annually over a period of two or three years from the grant date.

PSAs

PSAs are restricted shares or RSUs that are subject to the Company achieving certain earnings per share performance targets, as well as additional time-vesting conditions. The fair value of PSAs is based on the closing price of the Company’s common stock on the grant date.  The performance conditions must be met, or the PSAs are cancelled. If the performance conditions are met, the PSAs vest 50 percent at each of the second and third anniversary of the grant date.

Equity-based Compensation Expense

Equity-based compensation expense was reflected in the consolidated statements of operations as follows:

 

 

 

Thirteen Weeks Ended

 

 

Thirty-nine Weeks Ended

 

 

 

September 27,

2015

 

 

September 28,

2014

 

 

September 27,

2015

 

 

September 28,

2014

 

Cost of sales, buying and occupancy

 

$

187

 

 

$

152

 

 

$

418

 

 

$

546

 

Direct store expenses

 

 

294

 

 

 

215

 

 

 

762

 

 

 

580

 

Selling, general and administrative expenses

 

 

1,861

 

 

 

832

 

 

 

3,594

 

 

 

3,068

 

Equity-based compensation expense before income

   taxes

 

 

2,342

 

 

 

1,199

 

 

 

4,774

 

 

 

4,194

 

Income tax benefit

 

 

(885

)

 

 

(480

)

 

 

(1,804

)

 

 

(1,678

)

Net equity-based compensation expense

 

$

1,457

 

 

$

719

 

 

$

2,970

 

 

$

2,516

 

 

As of September 27, 2015 and December 28, 2014, there were approximately 7.5 million and 6.9 million options outstanding, of which 2.8 million and 0.9 million were unvested options, respectively.

At both September 27, 2015 and December 28, 2014, there were approximately 0.1 million unvested RSUs outstanding.

As of September 27, 2015 and December 28, 2014, there were approximately 0.1 million and no unvested PSAs, respectively.

As of September 27, 2015 total unrecognized compensation expense related to outstanding options was $15.1 million which, if the applicable service and performance conditions are fully met, is expected to be recognized over the next 2.4 years on a weighted-average basis.

As of September 27, 2015, total unrecognized compensation expense related to outstanding RSUs was $3.7 million which, if the service conditions are fully met, is expected to be recognized over the next 1.6 years on a weighted-average basis.

14


SPROUTS FARMERS MARKET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

As of September 27, 2015, total unrecognized compensation expense related to outstanding PSAs was $2.5 million which, if the performance conditions are fully met, is expected to be recognized over the next 2.0 years on a weighted-average basis. If performance conditions are not met, no expense will be recorded for the PSAs for which the conditions were not met.  As of September 27, 2015, it was not expected that the performance conditions would be met and no expense had been recorded for the PSAs.

During the thirty-nine weeks ended September 27, 2015 and September 28, 2014, the Company received $6.4 million and $7.6 million, respectively, in cash proceeds from the exercise of options.

 

 

15


 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K filed February 26, 2015 with the Securities and Exchange Commission. All dollar amounts included below are in thousands, unless otherwise noted.

Business Overview

Sprouts Farmers Market, Inc. operates as a healthy grocery store that offers fresh, natural and organic food that includes fresh produce, bulk foods, vitamins and supplements, grocery, meat and seafood, bakery, dairy, frozen foods, body care and natural household items catering to consumers’ growing interest in eating and living healthier. Since our founding in 2002, we have grown rapidly, significantly increasing our sales, store count and profitability. With 216 stores in thirteen states as of September 27, 2015, we are one of the largest specialty retailers of natural and organic food in the United States.

The cornerstones of our business are fresh, natural and organic products at compelling prices (which we refer to as “Healthy Living for Less”), an attractive and differentiated shopping experience, and knowledgeable team members who we believe provide best-in-class customer service and product education.

Healthy Living for Less.    We offer high-quality, fresh, natural and organic products at attractive prices in every department. Consistent with our farmers market heritage, our offering begins with fresh produce, which we source, warehouse and distribute in-house and sell at prices we believe to be significantly below those of other food retailers. In addition, our scale, operating structure and deep industry relationships position us to consistently deliver “Healthy Living for Less” throughout the store. Based on our experience, we believe we attract a broad customer base, including conventional supermarket customers, and appeal to a much wider demographic than other specialty retailers of natural and organic food. We believe that over time, our compelling prices and product offering convert many “trial” customers into loyal “lifestyle” customers who shop Sprouts with greater frequency and across an increasing number of departments.

Attractive, Differentiated Shopping Experience.    In a convenient, small-box format (average store size of 28,000 to 30,000 sq. ft.), our stores have a farmers market feel, with a bright open-air atmosphere to create a comfortable and engaging in-store experience. We strive to be our customers’ everyday healthy grocery store. We feature fresh produce and bulk foods at the center of the store surrounded by a complete grocery offering, including vitamins and supplements, grocery, meat and seafood, bakery, dairy, frozen foods, beer and wine, body care and natural household items. Consistent with our fresh, natural and organic offering, we choose not to carry most of the traditional, national branded consumer packaged goods generally found at conventional grocery retailers (e.g., Doritos, Tide and Lucky Charms). Instead, we offer high-quality, healthier alternatives that emphasize our focus on fresh, natural and organic products at great values.

Customer Service and Education.    We are dedicated to our mission of “Healthy Living for Less,” and we attract team members who share our passion for educating and serving our customers with the goal of making healthy eating easier and more accessible. We believe our well-trained and engaged team members help our customers increasingly understand that they can purchase a wide selection of high-quality, healthy, and great tasting food for themselves and their families at attractive prices by shopping at Sprouts.

Outlook

We are pursuing a number of strategies designed to continue our growth, including expansion of our store base, driving comparable store sales growth and growing the Sprouts brand. We intend to continue expanding our store base by pursuing new store openings in our existing markets, expanding

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into adjacent markets and penetrating new markets. We opened 24 stores and relocated one store during 2014. We expect to continue to expand our store base with 27 store openings planned in fiscal 2015, of which 26 have opened as of the date of this Quarterly Report on Form 10-Q. Although we plan to expand our store base primarily through new store openings, we may grow through strategic acquisitions if we identify suitable targets and are able to negotiate acceptable terms and conditions for acquisition. We aim to achieve 14% annual new store growth for at least the next five years.

We also believe we can continue to improve our comparable store sales growth by enhancing our core value proposition and distinctive customer-oriented shopping experience, as well as through expanding and refining our fresh, natural and organic product offerings, our targeted and personalized marketing efforts and our in-store education.  We are committed to growing the Sprouts brand by supporting our stores, product offerings and corporate partnerships, including the expansion of innovative marketing and promotional strategies through print, digital and social media platforms, all of which promote our mission of “Healthy Living for Less.”

Our History

In 2002, we opened the first Sprouts Farmers Market store in Chandler, Arizona. In 2010, we had 54 stores and reached over $620 million in net sales and approximately 3,700 team members. In April 2011, we partnered with investment funds affiliated with, and co-investment vehicles managed by, Apollo Management VI, L.P., and added 43 stores by merging with Henry’s Holdings, LLC and its Sun Harvest-brand stores. Our merger with Henry’s Holdings, LLC and new store openings brought us to 103 total stores located in Arizona, California, Colorado and Texas as of the end of 2011. In May 2012, we added another 37 stores through our acquisition of Sunflower Farmers Markets, Inc. and extended our footprint into New Mexico, Nevada, Oklahoma and Utah. In August 2013, we completed an initial public offering (“referred to as our IPO”) and our common stock began trading on the NASDAQ Global Select Market. Since the IPO, we have continued to expand, adding stores in our existing markets and extending into Kansas, Georgia, Missouri, Alabama and Tennessee.

Components of Operating Results

We report our results of operations on a 52- or 53-week fiscal year ending on the Sunday closest to December 31, with each fiscal quarter generally divided into three periods consisting of two four-week periods and one five-week period.  The third quarters of fiscal 2015 and 2014 were thirteen-week periods ended September 27, 2015 and September 28, 2014, respectively.

Net Sales

We recognize sales revenue at the point of sale, with discounts provided to customers reflected as a reduction in sales revenue. Proceeds from sales of gift cards are recorded as a liability at the time of sale, and recognized as sales when they are redeemed by the customer. In the second quarter of 2015, we determined that we had sufficient data to estimate gift card breakage. We began recording an allowance for breakage on gift cards based on historical experience, and recorded $0.8 million of gift card breakage related to prior period gift card sales. We do not include sales taxes in net sales.

We monitor our comparable store sales growth to evaluate and identify trends in our sales performance. Our practice is to include sales from a store in comparable store sales beginning on the first day of the 61st week following the store’s opening and to exclude sales from a closed store from comparable store sales beginning on the day of closure. We include sales from an acquired store in comparable store sales on the later of (i) the day of acquisition or (ii) the first day of the 61st week following the store’s opening. We also include sales from relocated stores immediately after relocation. These practices may differ from the methods that other retailers use to calculate similar measures.

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Net sales are affected by store openings and closings and comparable store sales growth. Factors that influence comparable store sales growth and other sales trends include:

 

·

general economic conditions and trends, including levels of disposable income and consumer confidence;

 

·

consumer preferences and buying trends;

 

·

our ability to identify market trends, and to source and provide product offerings that promote customer traffic and growth in average ticket;

 

·

the number of customer transactions and average ticket;

 

·

the prices of our products, including the effects of inflation and deflation;

 

·

opening new stores in the vicinity of our existing stores;

 

·

advertising, in-store merchandising and other marketing activities; and

 

·

our competition, including competitive store openings in the vicinity of our stores and competitor pricing and merchandising strategies.

Cost of sales, buying and occupancy and gross profit

Cost of sales includes the cost of inventory sold during the period, including direct costs of purchased merchandise (net of discounts and allowances), distribution and supply chain costs, buying costs and supplies. Merchandise incentives received from vendors are reflected in the carrying value of inventory when earned or as progress is made toward earning the rebate or allowance, and are reflected as a component of cost of sales as the inventory is sold. Inflation and deflation in the prices of food and other products we sell may affect our gross profit and gross margin. The short-term impact of inflation and deflation is largely dependent on whether or not we pass the effects through to our customers, which will depend upon competitive market conditions.

Occupancy costs include store rental, property taxes, utilities, common area maintenance, amortization of favorable and unfavorable leasehold interests and property insurance. Occupancy costs do not include building depreciation, which is classified as a direct store expense.

Our cost of sales, buying and occupancy and gross profit are correlated to sales volumes. As sales increase, gross margin is affected by the relative mix of products sold, pricing strategies, inventory shrinkage and improved leverage of fixed costs of sales, buying and occupancy.

Direct store expenses

Direct store expenses consist of store-level expenses such as salaries and benefits, related equity-based compensation, supplies, depreciation and amortization for buildings, store leasehold improvements, equipment and other store specific costs.

Selling, general and administrative expenses

Selling, general and administrative expenses primarily consist of salaries and benefits costs, equity-based compensation, advertising and corporate overhead.

We charge third-parties to place advertisements in our in-store guide and newspaper circulars. We record consideration received from vendors in connection with cooperative advertising programs as a reduction to advertising costs when the allowance represents reimbursement of a specific and identifiable cost. Advertising costs are expensed as incurred.

Store pre-opening costs

Store pre-opening costs include rent expense during construction of new stores and costs related to new store openings, including costs associated with hiring and training personnel and other miscellaneous costs. Store pre-opening costs are expensed as incurred.

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Store closure and exit costs

We recognize a reserve for future operating lease payments and other occupancy costs associated with facilities that are no longer being utilized in our current operations. The reserve is recorded based on the present value of the remaining non-cancelable lease payments and estimates of other occupancy costs after the cease use date less an estimate of subtenant income. If subtenant income is expected to be higher than the lease payments, no accrual is recorded. Lease payments and other occupancy costs included in the closed facility reserve are expected to be paid over the remaining terms of the respective leases. Our assumptions about subtenant income are based on our experience and knowledge of the area in which the closed property is located, guidance received from local brokers and agents and existing economic conditions. Adjustments to the closed facility reserve relate primarily to changes in actual or estimated subtenant income and changes in actual lease payments and other occupancy costs from original estimates. Adjustments are made for changes in estimates in the period in which the change becomes known, considering timing of new information regarding market, subleases or other lease updates. Changes in reserve estimates are classified as store closure and exit costs in the consolidated statements of operations.

Provision for income taxes

We must make certain estimates and judgments in determining income tax expense for financial statement purposes.  The amount of taxes currently payable or refundable is accrued and deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases.  Deferred tax assets are also recognized for realizable loss and tax credit carryforwards.  Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in income tax rates is recognized in our financial statements in the period that includes the enactment date.

 

 

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Results of Operations for Thirteen Weeks Ended September 27, 2015 and September 28, 2014

The following tables set forth our unaudited results of operations and other operating data for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. All dollar amounts are in thousands, unless otherwise noted.

 

 

 

Thirteen weeks ended

 

 

 

September 27,

2015

 

 

September 28,

2014

 

Unaudited Quarterly Consolidated Statement of Operations Data:

 

 

 

 

 

 

 

 

Net sales

 

$

903,069

 

 

$

766,415

 

Cost of sales, buying and occupancy

 

 

641,612

 

 

 

540,367

 

Gross profit

 

 

261,457

 

 

 

226,048

 

Direct store expenses

 

 

177,990

 

 

 

148,633

 

Selling, general and administrative expenses

 

 

27,075

 

 

 

24,015

 

Store pre-opening costs

 

 

1,825

 

 

 

3,684

 

Store closure and exit costs

 

 

167

 

 

 

60

 

Income from operations

 

 

54,400

 

 

 

49,656

 

Interest expense

 

 

(3,685

)

 

 

(6,157

)

Other income

 

 

171

 

 

 

281

 

Loss on extinguishment of debt

 

 

 

 

 

(1,138

)

Income before income taxes

 

 

50,886

 

 

 

42,642

 

Income tax provision

 

 

(18,900

)

 

 

(16,577

)

Net income

 

$

31,986

 

 

$

26,065

 

 

 

 

Thirteen weeks ended

 

 

 

September 27,

2015

 

 

September 28,

2014

 

Comparable store sales growth(1)

 

 

5.8

%

 

 

9.0

%

 

 

 

 

 

 

 

 

 

Other Operating Data:

 

 

 

 

 

 

 

 

Stores at beginning of period

 

 

208

 

 

 

177

 

Opened

 

 

8

 

 

 

14

 

Stores at end of period

 

 

216

 

 

 

191

 

 

(1)

See the explanation of “Comparable store sales growth” above under “Components of Operating Results – Net Sales.”

Comparison of Thirteen Weeks Ended September 27, 2015 to Thirteen Weeks Ended

September 28, 2014

Net sales

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

 

 

September 27, 2015

 

 

September 28, 2014

 

 

Change

 

 

% Change

 

Net sales

 

$

903,069

 

 

$

766,415

 

 

$

136,654